The decline in economic literacy is truly alarming. Consider the attached
Wall Street Journal editorial, which confuses the "Keynesian"
policies of expanding aggregate demand through high budget deficits during
recessions with the opposite--"classical": anti-Keynesian-- policies
of trying to balance the budget in recession.

Review & Outlook
Japan's Keynesian Flop

September 15, 1997

Japan's economy, it seems, has found its bottom line. Late last week,
the government revealed the awful statistic it had been hinting at: Gross
Domestic Product, measured at the annual rate, slumped 11.2% in the second
quarter this year from a year earlier. It was the worst economic swoon
since the "oil shock" of 23 years ago. Output has continued weak
through the summer months and officials aren't expecting much of a pickup
before next month.

We hate to say "we told you so," but the truth is that we
have chronicled Japan's journey to this unhappy state of being, offering
warnings about the policy mistakes along the way that brought it about.
The story began early in this decade, when it became apparent to us that
neo-Keynesianism was not dead after all, but was resurfacing in, of all
places, the onetime economic dynamo of Asia and the world.

Feeling low after the collapse of highly inflated real estate and securities
prices, Japan took a cue from newly
elected Bill Clinton, who was preaching government "infrastructure"
spending and higher taxes as the cure for what didn't ail the U.S. Fortunately
for America, Congress clamped some restraints on its young empire builder.
Japan wasn't so lucky. It plunged headlong
into a massive public spending program, sending its government deficit
and national debt soaring.

Then one day, the Japanese powers that be woke up and took a look at
all that red ink. True to the doctrine of big spenders everywhere, they
decided that the only way to cure a rising deficit was, of course, to raise
taxes. The Japanese people, wiser than their leaders in such matters, set
up a howl, but the politicians got their way, scheduling a rise in the
national sales tax to 5% from 3% to take effect last April 1.

They neglected to acknowledge that the massive Keynesian pump priming
hadn't provided the lift they expected. The economy had continued to limp
along with low and sometimes even negative growth through the early 1990s.
Instead of heeding the lessons of Margaret Thatcher, who ended England's
long nightmare with neo-Keynesian socialism in 1979 by unloading governmental
burdens, the Japanese lumbered on.

Having found that public spending wasn't getting the desired results,
they reached for another classic tool, monetary stimulus. Opening the monetary
taps last year was worth a try and didn't do Japan
any serious harm, because it by then was stuck in a deflationary mode.
But that didn't do much good either. The yen weakened against the dollar
and provided some export stimulus, but the overall economy was still beset
with deflationary effects of the bubble collapse and the misguided policies
adopted in response.

One reason monetary stimulus didn't work was that Japan's banks had
been so badly crippled by the real estate and stock market collapse--which
had left them with a mountain of bad debt and limited prospects for finding
creditworthy new borrowers--that they weren't very interested in taking
on new liabilities, even if the Bank of Japan
was offering them money for practically free. You can't stimulate an economy
by pumping out money if there is no one there to put it to good use.

But while none of the stimulatory methods were working, the drive to
"balance the budget" with new taxes rolled on. For awhile, it
looked as if something was finally happening last winter when the economy
picked up in the first quarter of 1997 to about a 4% growth rate. But that
brief moment of sunshine had been predicted. We now know for certain that
it was caused by heavy consumer buying of big ticket items in advance of
the tax increase. As soon as the sales tax boost kicked in, Japan
Inc., keeled over. Instead of buying, consumers were watching television.

Now, of course, Japan won't show
such a dismal result when GDP numbers for all four quarters of 1997 are
averaged out. But disappointment is spreading. Eisuke Sakakibara, vice
minister of finance, said last month that he thought Japan
still had a chance of meeting its target of 1.9% economic growth this year.
But that was before the magnitude of the second quarter slump was known.
Now Japanese officials doubt the country will achieve even that modest
growth level.

Government officials also feel boxed in. At the beginning of this month,
the finance ministry's administrative vice minister, Takeshi Komura, said
there is "no room" for further "stimulus" measures,
such as cutting taxes or boosting public spending. In other words, Japan's
officials stand frozen as they confront the country's public debt and deficit.
So Japan will float along, hoping for
the best, it seems, and taking comfort from that large trade surplus and
pile of foreign currency reserves that officialdom has cherished for so
many years. Yet, even that solace could diminish if the economic troubles
of Japan's trade partners in Asia continue to mount.

Maybe, in fact, it is now time to look at that trade surplus, the failure
of the public spending and money creation binge, and the idea that higher
taxes cure problems. Is it possible there's been something wrong with the
assumptions Japan's economic policy makers have held dear? And where did
they ever get the idea that neo-Keynesianism
was the way to go this late in the world-wide evolution away from such
approaches. They learned it, of course, from Bill Clinton.

And my King Canute-like attempt to shovel the tide of ignorance back
off the beach:

Letters to the EditorThe Wall Street Journal
1155 Avenue of the Americas
New York, NY

Dear Mesdames and Sirs:

Your September 15 editorial condemned the Japanese government's "drive
to balance the budget with new taxes" during its current deep recession.
You called its policies "Keynesian": "Japan's Keynesian
Flop" was the editorial's title.

But there is a big problem. John Maynard Keynes believed not in balancing
the budget but in running large deficits during deep recessions. The policies
of trying to balance the budget in a deep recession that you call "Keynesian"
are the policies that John Maynard Keynes called "Classical"--and
scorned.

As mistakes go, this is a howler: it is like praising Michelangelo for
his mastery of the Abstract Expressionist aesthetic, admiring the Federal
Register's mastery of poetic rhythm and rhyme, or expressing admiration
for the fundamental Communist principle of private property.

My advice? Tell your editorial writers to sharpen their pencils and
haul themselves down to NYU night school: they badly need to take the history-of-economic-thought
and the macroeconomic-analysis courses they slept through in college.

Brad DeLong
Professor of Economics
University of California at Berkeley